The crypto industry needs a crypto capital market structure

The past few weeks have been interesting and have surfaced what we in the financial services industry call matters requiring attention, or MRAs. An MRA describes a practice that deviates from sound governance, internal controls and risk management principles. These matters that require attention have the potential to adversely affect the industry and increase the risk profile. 

I have always focused on technology and innovation-led business models — systems and interconnected elements of blockchain-powered business networks — redefining the transaction systems that power many industries, including financial services. A growing number of naysayers have become vocal about recent events, which have revealed extensive mismanagement, ill-defined and misgoverned systems, and general misrepresentation of the industry. As a result, I want to take a systemic view of the industry to understand what led to this point, dissect the failings, and be prescriptive on how we can learn from failures and build upon successes.

Let’s first understand the market structure and what it means. That will help shed light on inefficiency in the current crypto market structure and allow me to make the case for a better-defined structure aimed at systemic fairness, robust information flow for risk profiles, and a convincing innovation narrative to revive the industry and instill confidence.

Understanding the current financial market structure

The modern financial market structure is essentially a chain of interconnected market participants that aid in accumulating capital and forming investment resources. These market participants have specific functions, such as asset custody, central bookkeeping, liquidity provisioning, clearing and settlement. Because of function, capital constraints or regulation, many of these entities are not vertically integrated, which prevents collusion or unilateral investment decisions. So, various products may be governed by different markets, but the fundamental financial primitives remain universal. For example, products such as stocks, bonds, futures, options and currencies all need to be traded, cleared and settled, and other functions such as collateralization, lending and borrowing ensue.

Financial markets work only where there is a supply of and demand for capital, and this is important. Today, the information between these interconnected participants is a function of sequential batched relay systems, and this asymmetric dissemination of information not only creates opacity but also inefficiency in terms of liquidity requirements, system trust costs in the form of fees and opportunity costs.

Blockchain and distributed ledger technology systems aim to solve these issues of time and trust with the characteristics of immutability and asymmetric dissemination of consistent information, which lends itself to trust and instant transaction processing. So, where did this go wrong? And why is the problem we were trying to solve becoming exponentially more complex and prevalent in crypto capital markets?

Creation of a crypto self-regulatory organization

It is important to create a self-regulatory organization (SRO) involving dominant industry players and major layer-1 protocols, which has the power to create industry standards, professional conduct guidelines and regulations to steer the industry in the right direction.

SROs are generally effective due to domain expertise and preserving the interest and reputation of the industry by providing guidelines and guardrails for new entrants and existing participants alike. Enforcement and violation can come through broader education and appeals to the community that supports a project, and this can be especially effective around robust crypto market data that provides insights into transparent data and the correlation of activities across the industry on related projects and related markets. This will also help the industry (by segments) to educate itself, work with regulators and policymakers, and forge partnerships.

Decoupling crypto

Decoupling is essential for the crypto industry to provide both diversity in the investment landscape and a model for efficient and resilient asset classes, transaction systems and an effective market structure. As we have seen with stablecoins, which inherit elements of global macro strategy and increased correlation, rethinking the industry’s ability to create value on its own merits and a new fundamental model that will not only create a convincing innovation narrative but also provide the markets a new independent asset class with sound fundamentals. This also is aligned with the fundamental principle that led to the genesis of Bitcoin-led crypto innovations. Decoupling in scientific terms also refers to reducing the number of resources used to generate economic growth while decreasing environmental deterioration and ecological scarcity.

Related: The decoupling manifesto: Mapping the next phase of the crypto journey

Looking forward

A modern financial market structure is essentially a chain of interconnected market participants that aid in accumulating capital and forming investment resources. The industry needs a sound market structure and systemic independence from current transactional systems. One of the industry imperatives is not only to coexist with current market structures but also to provide a bridging vehicle to current asset classes.

Earlier, I discussed several MRAs that are essential for stronger and more resilient markets. The changes proposed to fix the volatile and runaway nature of the industry include (but are not limited to): a) rethinking stablecoins and liquidity, b) robust crypto market data for efficient market functioning, c) creation of a crypto self-regulated organization and enforcement via community actions, and d) decoupling crypto — essentially rethinking the industry’s ability to create value on its own merits and a new fundamental model that will not only create a convincing innovation narrative but also provide the markets a new independent asset class with sound fundamentals.

Nitin Gaur has recently joined State Street Digital as its managing director, where he leads digital asset and technology design, with aspirations to transition part of the company’s financial market infrastructure and its clients to the new digital economy. In a previous role, Nitin, served as the founder and director of IBM Digital Asset Labs — committed to devising industry standards, use cases and working toward making blockchain for enterprise a reality. In parallel, Nitin also served as chief technology officer of IBM World Wire — a cross-border payment solution utilizing digital assets. Nitin also founded IBM Blockchain Labs and led the effort in establishing blockchain practice for the enterprise.